Revised Fall 2012
CHAPTER 8
ACCOUNTING FOR LONG-TERM
ASSETS
Key Terms and Concepts to Know
Long-term assets:
 Determine the cost of the asset
 Salvage or residual value
 Useful life
 Tangible assets
 Intangible assets
 Betterments vs. extraordinary repairs vs. ordinary repairs expense
Depreciation/Depletion/Amortization Methods:
 Straight-line method
 Units-of-production method
 Double-declining balance method
 Full year vs. partial year depreciation expense
 Changes in estimates for depreciation
Disposal of Long-term assets:
 Discard
 Sale
 Gain/loss vs. revenue /expense
Leases:
 Lessor – owner of the property
 Lessee – user of the property
 Leasehold – rights in the property granted by the lessor via the lease document to
the lessee
 Leasehold improvements are the additions or changes the lessee makes to the
leased property. Leasehold improvements are an asset to the lessee and are
amortized over the remaining life of the lease.
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Revised Fall 2012
Key Topics to Know
Principles of Depreciation
Depreciation is:
 The allocation of the cost of an asset to the periods it is used.
 Not an attempt to track the market value of the asset.
 Required because physical deterioration and/or obsolescence cause all fixed assets
to lose their usefulness.
 Land is not depreciated because it does not lose its usefulness.
 Recorded, for income statement purposes, as an expense to match revenues
generated by using the asset with the expenses incurred to produce the revenue.
 Recorded, for balance sheet purposes, in a contra account called Accumulated
Depreciation. The fixed asset account is not directly reduced because
depreciation is only an estimate of how much of its usefulness has expired.
 Recorded for the period the asset is owned, typically every month but certainly at
the end of each fiscal year. Depreciation expense may have to be adjusted in the
year of acquisition and/or the year of disposal to reflect the actual number of
months the asset was owned.
Depreciation Methods
Straight-Line Method
 Allocates the cost of the asset to expense evenly over years asset is used.
 The life of the asset is measured in years.
 Formula is: (Cost – Residual Value) / Estimated Life = Annual Depreciation
Example #1: Company F purchased a machine that cost $50,000 and will last 5 years.
A salvage value was not assigned to the asset. Determine the annual depreciation
expense using the straight-line method and prepare the journal entry to record the
expense.
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Revised Fall 2012
Solution #1:
$50,000 / 5 years = $10,000 per year
$10,000 = portion of cost to be expensed for each full year of use
$50,000 / 5 years = $10,000 per year
$10,000 = portion of cost to be expensed for each full year of use
Depreciation Expense-Machinery
Accumulated Depreciation- Machinery
10,000
10,000
Practice Problem #1
Company Q purchased a piece of equipment that cost $250,000 on January 1, 2011.
The equipment will last 8 years and have a residual value of $10,000. On October 1,
2011, the company purchased another piece of equipment identical to the first.
Calculate the depreciation expense for 2011 for each piece of equipment.
Units-of-Production Method
 Allocates the cost of the asset to expense based on a measure of how much the
asset was used each period.
 The life of an asset is measured in units of activity, i.e. miles, or hours used.
 Formula is: (Cost – Residual Value) / Estimated Life in Units = Depreciation
Expense Per Unit
 Depreciation Expense Per Unit x units used in the period = Depreciation Expense
for the period
Example #2: Company F purchased a machine that cost $50,000 and will be able to
produce 500,000 units of product before wearing out. Expected production by year will
be: year 1 – 80,000 units; year 2 – 100,000; year 3 – 100,000; year 4 – 110,000 and
year 5 – 110,000. A salvage value was not assigned to the asset. Determine the annual
depreciation expense using the units-of-production method and prepare the journal
entry to record the expense.
Solution #2:
$50,000 / 500,000 units = $.10 per unit
$.10 x 80,000 units produced = $8,000 depreciation expense for year 1
Depreciation Expense-Machinery
Accumulated Depreciation- Machinery
Page 3 of 19
8,000
8,000
Revised Fall 2012
Practice Problem #2
A company purchased machinery that cost $510,000. It is estimated that the machine
will be operated for 100,000 hours over its useful life and have a residual value of
$10,000.
Required:
a) What is the rate of depreciation per hour?
b) Journalize the entry for annual depreciation if the
machine had been operated for 22,000 hours.
Declining Balance Method
 Allocates more of the cost of the asset to expense in the first years of the useful
life and less in the later years.
 The life of the asset is measured in years.
 Formula is: (Cost – Accumulated Depreciation) * Declining Balance Rate
OR
Book Value * Declining Balance Rate
 Rate = Double the straight-line method rate: (100%/useful life) x 2
OR
200% / useful life
 Residual Value is not used in the calculation of annual depreciation until the last
year. An asset may not be depreciated below its residual value.
Example #3: Company F purchased a machine that cost $50,000 and will last 5 years.
A salvage value was not assigned to the asset. Determine the annual depreciation
expense using the declining balance method and prepare the journal entry to record the
expense.
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Revised Fall 2012
Solution #3:
Beginning
Depreciation Depreciation Ending
Accumulated
Year book value rate
expense
book value depreciation
1
50,000
40%
20,000
30,000
20,000
2
30,000
40%
12,000
18,000
32,000
3
18,000
40%
7,200
10,800
39,200
4
10,800
40%
4,320
5,680
44,880
5
5,680
40%
2,272
3,408
47,152
Depreciation Expense-Machinery
Accumulated Depreciation- Machinery
20,000
20,000
It is typical of the declining balance method that assets without a residual value are not
fully depreciated. That is, at the end of their useful life, the book value is not zero. For
this reason, many companies switch from the declining balance method to the straightline method when depreciation expense for the declining balance method becomes less
than under the straight line method.
Example #4: Purchased equipment for $70,000. This equipment has a 5 year life and
an $8,000 residual value. Calculate depreciation for each of the five years using the
declining balance method at twice the straight-line rate.
Solution #4:
Straight-line rate = 1/5 or 20%; Declining Rate = 40%
Maximum Depreciation allowed = $62,000
Beginning
Depreciation Depreciation Ending
Accumulated
Year book value rate
expense
book value depreciation
1
70,000
40%
28,000
42,000
28,000
2
42,000
40%
16,800
25,200
44,800
3
25,200
40%
10,080
15,120
54,880
4
15,120
40%
6,048
9,072
60,928
5*
9,072
40%
1,072
8,000
62,000
*In Year 5, the asset may not be depreciated beyond its residual value. That is, the net
book value may not be less than the residual value. Applying the double declining
balance method in year 5 calculates an expense of (70,000 – 60,928) * 40% =
$3,628.80 which reduces the book value below the residual value.
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Revised Fall 2012
Practice Problem #3
A company purchased a machine that cost $100,000. The machine is expected to last 4
years and has a residual value of $7,000. Calculate the depreciation expense to be
recorded each year under the declining balance method.
Disposal of Long-Term Assets
For all disposals of plant assets:
 Accumulated depreciation and depreciation expense must be calculated and
recorded in the general ledger through the date of disposal. That is, they must be
brought up to date before recording the disposal.
 The book value or cost of the asset less its accumulated depreciation must be
removed from the accounting records.
 If the asset is disposed of for more than its book value, the seller records a gain
on disposal. If the asset is disposed of for less than its book value, the seller
records a loss on disposal.
Discarding a Plant Asset
 Update depreciation to date of disposal.
 Remove the asset and its accumulated depreciation from the accounting records.
 If the asset is not fully depreciated, record a loss equal to its book value.
Example #5: On January 2 Company W discarded Machine #1, which originally cost
$10,000 and has accumulated depreciation of $10,000. Prepare a journal entry to
record the discarding of the machinery.
Solution #5:
Accumulated Depreciation- Machinery
Machinery
10,000
10,000
Example #6: On January 2 Company W discarded Machine #2, which originally cost
$25,000 and has accumulated depreciation of $20,000. Prepare a journal entry to
record the discarding of the machinery.
Solution #6:
Accumulated Depreciation- Machinery
Machinery
Loss on disposal
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20,000
5,000
25,000
Revised Fall 2012
Practice Problem #4
Journalize the entry to discard equipment on January 2, originally costing $50,000 and
having accumulated depreciation on $42,000.
Sale of a Plant Asset
 Update depreciation to date of disposal.
 Remove the asset and its accumulated depreciation from the accounting records.
 If the asset is not fully depreciated, record a loss equal to its book value.
 Record a gain or loss: Gain if cash received exceeds book value OR
Loss if book value exceeds cash received
Example #7: On October 1, a machine that cost $50,000 was sold for $16,000. The
accounting records revealed that accumulated depreciation as of January 1 was $35,000
and annual depreciation is $5,000.
Solution #7:
 $5,000 * 9 months / 12 months = $3,750 depreciation expense for January thru
September
 Accumulated depreciation at disposal date = $35,000 + $3,750 = $38,750
Depreciation Expense-Machinery
Accumulated Depreciation- Machinery
 Gain on disposal:
Selling Price
-Book Value
Gain
3,750
3,750
$16,000
11,250 (50,000 - 38,750)
4,750
Cash
Accumulated Depreciation- Machinery
Machinery
Gain on disposal
16,000
38,750
50,000
4,750
Practice Problem #5
On July 1 a machine, which cost $75,000, was sold for $4,000. The following
information was obtained from the accounting records: accumulated depreciation on
December 31, $61,250; annual depreciation, $8,750.
Required:
a) Journalize depreciation expense to the date of sale
b) Journalize the sale of the equipment
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Revised Fall 2012
Depletion of Natural Resources
 Mining companies purchase rights to metal ore or mineral deposits. These rights
are recorded in an asset account when they are purchased.
 As ore is mined, part of the cost must be removed from the asset account. This
process is called depletion.
 The depletion method is the same as Units of Production Method.
 The accumulated depletion account is credited when the asset is amortized.
Amortization of Intangible Assets
 The periodic expensing of the cost of intangible assets.
 The Straight-line Method is used.
 Intangibles are amortized over their useful life, not to exceed 40 years.
 The accumulated amortization account is credited when the asset is amortized.
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Revised Fall 2012
Sample True / False Questions
1.
Long-term assets are recorded at cost less all expenditures necessary to get
the asset ready for use.
True False
2.
Cash received from the sale of salvaged materials increases the total cost of
land.
True False
3.
Land improvements are recorded separately from the land itself because,
unlike land, these assets are subject to depreciation.
True False
4.
Purchased intangible assets are recorded at their original cost plus all other
costs necessary to get the asset ready for use.
True False
5.
A patent is an exclusive right to a published work such as a song, film, or
painting.
True False
6.
Repairs and maintenance expenditures are capitalized because they maintain a
given level of benefits.
True False
7.
If a firm successfully defends an intangible right, it should expense the
litigation costs as incurred.
True False
8.
Depreciation in accounting is the process of allocating to expense the cost of
an asset over its service life.
True False
9.
Accumulated Depreciation is a liability account that is increased by credits.
True False
10. Book value is equal to the original cost of the asset minus the current balance
in Accumulated Depreciation.
True False
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Revised Fall 2012
11. The Accumulated Depreciation account allows us to reduce the carrying value
of assets through depreciation, while maintaining the original cost of each
asset in the accounting records.
True False
12. When a change in estimate is required, the company changes depreciation in
prior, current and future years.
True False
13. Declining-balance depreciation will be lower than straight-line depreciation in
earlier years, but higher in later years.
True False
14. The cost of natural resources is allocated to expense through a process known
as depletion.
True False
15. Straight-line, declining-balance, and activity-based depreciation all are
acceptable depreciation methods for both financial reporting and tax
reporting.
True False
16. Intangible assets with an indefinite useful life (goodwill and most trademarks)
are not amortized.
True False
17. A gain is recorded if an asset is sold for less than book value.
True False
18. A loss is recorded if an asset is sold for less than book value.
True False
19. Straight-line depreciation assumes that the benefits we derive from the use of
an asset are the same each year.
True False
20. Depreciation in accounting records the decrease in value of an asset.
True False
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Revised Fall 2012
Sample Multiple Choice Questions
1.
Undeveloped land acquired as a speculation is listed in the balance sheet as
a(n):
a. Current asset
b. Investment
c. Plant asset
d. Intangible asset
2.
Ordinary repairs are reported on
a) Balance sheet
b) Income statement
c) Statement of retained earnings
d) Statement of cash flows
3.
Accumulated Depreciation
a) Is used to show the amount of cost expiration of intangibles
b) Is the same as Depreciation Expense
c) Is used to show the amount of cost expiration of natural resources
d) Is a contra asset
4.
A machine with a cost of $130,000 has an estimated residual value of $10,000
and an estimated life of 4 years or 18,000 hours. What is the amount of
depreciation for the second full year, using the declining-balance method at
double the straight-line rate?
a) $30,000
b) $31,500
c) $32,500
d) $65,000
5.
A machine with a cost of $130,000 has an estimated residual value of $10,000
and an estimated life of 4 years or 16,000 hours. Using the units-ofproduction method, what is the amount of deprecation for the second full
year, during which the machine was used 4,000 hours?
a) $26,000
b) $24,000
c) $30,000
d) $32,500
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Revised Fall 2012
6.
Equipment with a cost of $80,000 has an estimated residual value of $5,000
and an estimated life of 4 years or 12,000 hours. It is to be depreciated by
the straight-line method. What is the amount of depreciation for the first full
year, during which the equipment was used 3,300 hours?
a) $20,000
b) $18,750
c) $20,625
d) $22,000
7.
Patents are reported on the balance sheet in the:
a) Current assets section
b) Intangible assets section
c) Plant assets section
d) Investments section
8.
All things being equal except the net sales to average total assets, a lender
would prefer to lend to a company whose ratio is
a) 4.0
b) 2.5
c) 3.0
d) 3.5
9.
A company has the following asset account balances:
Buildings & Equipment
$9,200,000
Accumulated Depreciation
1,200,000
Patents
750,000
Land Improvements
1,000,000
Land
5,000,000
The total amount reported on the balance sheet under Property, Plant &
Equipment would be:
a) $14,000,000
b) $13,000,000
c) $12,800,000
d) $13,550,000
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Revised Fall 2012
10. A purchase of equipment for $18,000 also involved freight charges of $500
and installation costs of $2,500. The estimated salvage value and useful life
are $2,000 and 4 years, respectively. Annual straight-line depreciation
expense will be:
a) $4,750
b) $4,500
c) $4,125
d) $4,625
11. An asset purchased on January 1 for $48,000 has an estimated salvage value
of $3,000. The current year’s Depreciation Expense is $5,000 and the balance
of the Accumulated Depreciation account, after adjustment, is $20,000. If the
company uses the straight-line method, what is the asset’s remaining useful
life?
a) 9 years
b) 4 years
c) 8 years
d) 5 years
12. Coronado Company purchased land for $80,000. The company also paid
$12,000 in accrued taxes on the property, incurred $5,000 to remove an old
building, and received $2,000 from the salvage of the old building. The land
will be recorded at:
a) $80,000
b) $95,000
c) $92,000
d) $83,000
13. On April 1, 2001 La Presa Company sells some equipment for $18,000. The
original cost was $50,000, the estimated salvage value was $8,000, and the
expected useful life was 6 years. On December 31, 2000 the Accumulated
Depreciation account had a balance of $29,400. The gain or loss on the sale
was:
a) $2,600 gain
b) $300 gain
c) $850 loss
d) $5,400 gain
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Revised Fall 2012
14. On January 1, 2000 Jamacha Company purchased some equipment for
$15,000. The estimated salvage value and useful life are $3,000 and 4 years,
respectively. On January 1, 2002, the company determines that the asset’s
remaining useful life is 3 years. What is the revised depreciation expense for
2002 if the company uses the straight-line method?
a) $3,000
b) $2,000
c) $4,000
d) $2.250
15. On March 1, 2002, Moreno Company purchased a patent from another
company for $90,000. The estimated useful life of the patent is 10 years, and
its remaining legal life is 15 years. The Amortization Expense for 2002 is:
a) $9,000
b) $7,500
c) $6,000
d) $5,000
16. On September 1, 2001, Dulzura Company purchased an asset for $9,000, with
a $1,500 estimated salvage value, and a 4-year useful life. The 2001
depreciation expense using the straight-line method would be:
a) $625
b) $750
c) $1,875
d) $2,250
17. Otay Company purchased land for $70,000 on 12/31/01. As of 5/30/02, the
land increased in value to $71,500. On 12/31/02, the land was appraised for
$74,000. The Land account should be increased by:
a) $4,000
b) $1,500
c) $2,500
d) $0
18. Which of the following costs would not be included in the cost of the
equipment?
a) Insurance
b) Installation
c) Testing
d) Freight
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Revised Fall 2012
19. Which of the following is not a depreciable asset?
a) Land improvements
b) Equipment
c) Buildings
d) Land
Page 15 of 19
Revised Fall 2012
Solutions to Practice Problems
Practice Problem #1
First piece of equipment: (250,000 – 10,000) / 8 years = 30,000 expense for
2011
Second piece of equipment: (250,000 – 10,000) / 8 years = 30,000 for all of
2011
However, equipment was acquired on October 1, so it was used for 3 months
in 2011: 30,000 x 3 months / 12 months = 7,500 for 2011
Practice Problem #2
(510,000 – 10,000) / 100,000 hours = $5 per hour
22,000 hours for the year * $5 per hour = $110,000
Depreciation Expense
Accumulated Depreciation
110,000
110,000
Practice Problem #3
4 year life = ¼ or 25% per year under straight-line depreciation
Double rate to 50% for declining balance depreciation or 200%/4 years = 50%
Maximum depreciation allowed: 100,000 – 7,000 = 93,000
Beginning
Depreciation Depreciation Ending
Accumulated
Year book value rate
expense
book value depreciation
1
100,000
50%
50,000
50,000
50,000
2
50,000
50%
25,000
25,000
75,000
3
25,000
50%
12,500
12,500
87,500
4
12,500
50%
*5,500
7,000
93,000
*Maximum depreciation allowed in year 4 is $5,500 which brings accumulated depreciation to
$93,000. The asset may not be depreciated below its residual value of $7,000.
Practice Problem #4
Accumulated Depreciation
Loss on disposal
Equipment
42,000
8,000
50,000
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Revised Fall 2012
Practice Problem #5
Depreciation Expense
Accumulated Depreciation
4,375
4,375
8,750 * ½ year = $4,375 ; Accumulated Depreciation: 61,250 + 4,375 = $65,625
Cash
Accumulated Depreciation
Loss on disposal
Equipment
4,000
65,625
5,375
75,000
Page 17 of 19
Revised Fall 2012
Solutions to True / false Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
False - long-term assets are recorded at cost plus all expenditures
necessary to get the asset ready for use.
False - cash received from the sale of salvaged materials decreases the
total cost of land.
True
True
False - a patent is an exclusive right to manufacture a product or to use
a process. A copyright is an exclusive right of protection given to the
creator of a published work such as a song, film, painting, photograph,
book, or computer software.
False - repairs and maintenance expenditures are expensed in the period
incurred because they maintain a given level of benefits.
False - if a firm successfully defends an intangible right, it should
capitalize the litigation costs and amortize them over the remaining
useful life of the related intangible.
True
False - accumulated Depreciation is a contra-asset account; it reduces an
asset account.
True
True
False - when a change in estimate is required, the company changes
depreciation in current and future years, but not in prior periods.
False - declining-balance depreciation will be higher than straight-line
depreciation in earlier years, but lower in later years.
True
False - these are acceptable methods for financial reporting, not tax
reporting. Most companies use MACRS for income tax depreciation.
True
False - a gain is recorded if an asset is sold for more than book value.
True
True
False - Depreciation in accounting is the process of allocating to expense
the cost of an asset over its service life.
Page 18 of 19
Revised Fall 2012
Solutions to Multiple Choice Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
B
B
D
C
C
B
B
A
A
A
D
B
C
B
A
A
D
A
D
Page 19 of 19